The following is supplementary to my blog entries of July 3rd, July 4th and yesterday. There is a specific reason that China is not anxious to allow its currency to appreciate too rapidly, based on a previous set of circumstances experienced by Japan. Let me explain.

Throughout the 1980s, Japan’s foreign trade surplus with the United States continued to build at an alarming rate. Therefore, in 1985 the Plaza Accord was struck (at the Plaza Hotel in New York), setting out an agreement among central bankers whereby the value of the yen would rise relative to the U.S. dollar.

Over the intervening years, Japan’s current account surplus has moderated, although it remains in substantial surplus. At the same time, the U.S. trade deficit with China has grown huge, while its shortfall with Japan has eased.

Only two days into 1990, Japan’s commercial real estate sector (as expressed by land prices) and its major stock market index fell into disarray. Even today, Tokyo’s Nikkei index remains at a level only about one-third as high as it was eighteen years ago.

Throughout the ensuing 1990s, the government’s attempted answer to move the economy out of stagnation was massive spending on infrastructure projects. The net effect has been to leave the nation saddled with enormous government debt. Japan’s public debt to GDP ratio is by far the highest among all industrialized nations. Furthermore, Japan continues to wallow in slow economic growth, despite a central-bank interest rate of only 0.5%.

No wonder China has, so far, resisted demands that it adjust its currency radically upward (i.e., beyond the current 16% appreciation versus the U.S. dollar since July 2005). Nevertheless, China is now facing its own problems − a current rate of inflation approaching 8% that threatens social unrest over the high cost of food and other essentials. The two easiest ways to address rising domestic prices in China would be to hike interest rates and/or allow the value of the Yuan to rise further. China’s reluctance to do the latter is partly based on Japan’s experience under similar circumstances.

Having said all of the foregoing, perhaps the most significant advantage that China has over Japan lies in the area of government debt. Both countries have large trade surpluses. However, in Japan’s case, that is not money that is available to the government, due to private ownership of firms. However, in China, the largest exporters are government enterprises. Therefore, its huge trade surplus is safely buried away as a nest egg in the coffers of the government.

(This entry is partly based on an article appearing in The Globe and Mail newspaper on May 10, 2008, reporter Marcus Gee.)

For the impacts on Canada’s construction forecasts, see the Market Insights story dated July 21st.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

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